United States: Regulation Crowdfunding

Crowdfunding is a relatively new means through which businesses or individuals can harness the reaches of the internet to raise capital by seeking small individual contributions from a large number of people. Crowdfunding has been utilized to fund clothing start-ups and artistic endeavors, and even President Barack Obama's 2008 presidential campaign, whereby President Obama raised over $200 million in singular donations under $200.1 Typical crowdfunding transactions have generally involved financing a particular project in expectation of receiving a tangible reward relating to such project — a music album, for example.

Crowdfunding has generally not involved the offer to share in the profits generated from the activities financed through such crowdfunding. This model of crowdfunding, referred to as the "equity model," would likely trigger the application of federal securities laws as it would likely involve the offer and sale of securities to the public. Absent an available exemption, the small businesses and startups seeking to utilize the equity model of crowdfunding to fund a particular endeavor would need to register the securities offered prior to any offer or sale under the Securities Act of 1933, as amended (the "Securities Act"). The costs associated with conducting a registered offering of securities relative to the aggregate amount of capital typically sought by small businesses and startups, and the limitations applicable to conducting an offering exempt from registration, have generally been cited as the key factors that have prevented the equity model of crowdfunding from being effective and practical for small businesses and startups.

Title III of the Jumpstart Our Business Startups Act (the "JOBS Act"), established the regulatory framework for small businesses and startups to raise capital using the "equity model" in a less costly manner by offering securities over the internet. Title III exempts from registration crowdfunding transactions that (i) meet certain volume limitations, (ii) are conducted by issuers who comply with certain disclosure, conduct and ongoing reporting requirements, and (iii) are conducted through a regulated intermediary. Congress directed the Securities and Exchange Commission (the "SEC") to issue rules necessary and appropriate to carry out the provisions of Title III (such rules, collectively, "Regulation Crowdfunding"). Notably, and in contrast to the relatively succinct sections of the JOBS Act respecting new private placement and Regulation A rules, Title III sets forth the statutory requirements for crowdfunding transactions in extensive detail.

Despite a December 31, 2012 deadline to finalize Regulation Crowdfunding, the SEC released final rules on October 30, 2015.

I. Volume Limitations

A crowdfunding transaction will be exempt provided:

  1. the aggregate amount sold to all investors is not more than $1 million during the 12-month period preceding the transaction, and
  2. the aggregate amount sold to any investor during the 12-month period preceding the transaction does not exceed

    1. the greater of $2,000 or 5 percent of the annual income or net worth of such investor, if either is less than $100,000, and
    2. 10 percent of the annual income or net worth of such investor, not to exceed an aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or is greater than $100,000.

The JOBS Act does not make the crowdfunding exemption available to any issuer that:

  1. is not organized under and subject to the laws of a state or territory of the United States or the District of Columbia;
  2. is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act");
  3. is an investment company, as defined in the Investment Company Act of 1940, as amended (the "Investment Company Act");2 or
  4. the SEC, by rule or regulation, determines not to be entitled to the benefits of the exemption.

Regulation Crowdfunding largely tracks the language of the JOBS Act with respect to volume limitations. The rules determine an investor's net worth and annual income for the purposes of determining the individual volume limitation using the same method of calculation used for the purposes of determining accredited investor status for natural persons pursuant to Rule 501 of Regulation D.3

The SEC noted that the JOBS Act created statutory ambiguity as to whether the 12-month volume limitation applied to the aggregate of amounts raised in all exempt transactions, or just transactions that involved crowdfunding. However, it determined that the "overall intent of providing the exemption under [Regulation Crowdfunding] was to provide an additional mechanism for capital raising for startup and small businesses and not to affect the amount an issuer could raise outside of the exemption."

Thus, the 12-month, $1 million limit applies only to offerings made under Regulation Crowdfunding specifically. "The opposite approach" the SEC concluded, "would be inconsistent with the goal of alleviating the funding gap faced by startups and small businesses . . ." Issuers would be required to include all securities sold in reliance on Regulation Crowdfunding by entities controlled by or under common control with the issuer, including any predecessor of the issuer. As the JOBS Act did not define "controlled by or under common control with," the SEC proposed to use the term "control" as defined in Rule 405 of the Securities Act.4

Furthermore, the SEC adopted an approach that limited an investor from investing: (1) the greater of $2,000 or 5% of the lessor of the investor's annual income or net worth if either annual income or net worth is less than $100,000; or (2) 10% of the lessor of the investor's annual income or net worth, not to exceed an amount sold of $100,000, if both annual income and net worth are $100,000 or more. In addition to the statutory prohibitions, the SEC excluded from Regulation Crowdfunding any issuer that:

  1. is disqualified pursuant to the "bad actor" rules (discussed below),
  2. has sold securities under the crowdfunding exemption, but has not complied with the ongoing reporting requirements (discussed below) applicable to such issuer under Regulation Crowdfunding, or
  3. has no specific business plan or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.

To read this Report in full, please click here.


1. VEIKKO ERANTI & JUHO LINDMAN, CROWDSOURCING & CROWDFUNDING A PRESIDENTIAL ELECTION 2 (2013), available at http://ipp.oii.ox.ac.uk/sites/ipp/files/documents/IPP2014_Eranti.pdf.

2. The statute also prohibits private funds from engaging in crowdfunding transactions.

3. 78 Fed. Reg. 66,433-43. The definition of the term "accredited investor" under Rule 501(a) of Regulation D as applied to a natural person is a person: (i) whose individual net worth, or joint net worth with that person's spouse, exceeds $1 million, excluding the value of the person's primary residence and certain related indebtedness (the "net worth test"); or (ii) who had an individual income in excess of $200,000 in each of the two most recent years, or joint income with that person's spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year (the "income test"). 17 C.F.R. 230.501(a).

4. Id. See 17 C.F.R. 230.405 ("The term control (including the terms controlling, controlled by and under common control with) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.")

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